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Southwest Airlines Will Return More Cash to Shareholders

Last week, the low-fare airline hiked its dividend again and announced a new $2 billion share repurchase program.

Earlier this month, I wrote that Southwest Airlines(NYSE:LUV)stock looks cheap. While the company faces some short-term headwinds related to a temporary shortage of aircraft and a slowdown in bookings following last month's fatal accident, its longer-term profit growth outlook remains solid.

Southwest Airlines' board and management seem to agree with this assessment. Last week, in conjunction with the company's annual meeting, Southwest Airlines raised its dividend by 28% and announced a new $2 billion share repurchase program.

Another big capital return announcement

As airline industry profitability has risen over the past several years, Southwest Airlines has significantly increased the amount of cash it returns to shareholders.

First, Southwest has increased its dividend substantially. Prior to 2013, the company only paid a nominal quarterly dividend of $0.01 or less per share. However, in 2013, Southwest Airlines quadrupled its quarterly dividend to $0.04 per share. In the past five years, the company has quadrupled its dividend again. The new quarterly dividend is $0.16 per share, giving Southwest Airlines stock a 1.2% annual yield.

Second, Southwest's board has approved a new $2 billion share repurchase authorization. That's enough to shrink the share count by almost 7%. Southwest Airlines will begin working on this new buyback program after it completes the last $350 million of its current share buyback plan.

In recent years, share repurchases have represented a much larger piece of Southwest's capital return activity than dividends. Based on its current share count and its new $0.16 quarterly dividend, Southwest Airlines will disburse a little more than $370 million in dividend payments annually. By contrast, it has routinely spent more than $1 billion a year on share repurchases since 2015. In fact, Southwest devotes nearly all of its free cash flow to buybacks.

Free cash flow is set to rise

Fortunately for shareholders, Southwest Airlines' free cash flow -- and thus its cash available for share buybacks -- is set to rise in 2018 and beyond. Most notably, the reduction of the federal corporate tax rate from 35% to 21% will slash Southwest's annual tax liability by hundreds of millions of dollars. A rule that allows companies to expense 100% of their capital expenditures for the next five years will provide additional cash savings.

Furthermore, based on the timing of Southwest Airlines' aircraft orders, capex will moderate for the next couple of years before bouncing back in the early 2020s. That will provide a short-term boost to free cash flow.

Looking a little further ahead, Southwest Airlines expects to get $500 million of incremental annual revenue from a new reservation system it started using last year. It has captured less than half of that amount thus far. Meanwhile, the replacement of some of Southwest's oldest planes with new state-of-the-art 737 MAX 8s over the next several years will provide meaningful cost savings.

It's still a good time to buy

Analysts currently project that adjusted earnings per share will reach $4.54 at Southwest Airlines in 2018, up from $3.50 last year. On average, analysts expect Southwest to achieve another year of double-digit EPS growth in 2019, with EPS rising to $5.33. Based on that estimate, Southwest Airlines stock currently trades for slightly less than 10 times forward earnings.

This makes the stock look like an incredible bargain. Southwest Airlines has a pristine balance sheet, several near-term earnings growth drivers, and ample room for future expansion. The company's shareholder-friendly commitment to dividend growth and substantial share buybacks make Southwest Airlines a compelling choice for long-term investors.

Author

Adam Levine-Weinberg is a senior Industrials/Consumer Goods specialist with The Motley Fool. He is an avid stock-market watcher and a value investor at heart. He primarily covers airline, auto, retail, and tech stocks. Follow him on Twitter for the latest news and commentary on the airline industry! Follow @AdamLLW